How Debtor’s Attorneys Can Use DIP Financing to Cut Through the Competition and Win New Business

Economic downturns are invariably associated with an increase in bankruptcy filings, and the most recent COVID-induced recession is no exception. Even with federal interventions like the Paycheck Protection Program, business bankruptcy filings are still predicted in large numbers. In fact, since the pandemic hit the U.S. in March 2020, the number of bankruptcy filings each month has been greater than every corresponding month in 2019.

Anticipating an explosive increase in bankruptcy filings, law firms have rushed to address the need. The American Lawyer reported in October that lateral hiring for bankruptcy attorneys surged over 30% compared to the three-year average,^[1] against the general industry trend of decreasing lateral movement. Simultaneously, according to the Wall Street Journal, private debt funds have raised a record $55.5 billion in the first half of 2020, much of that earmarked for distressed strategies.^[2] The COVID-19 pandemic has indisputably primed the bankruptcy market.

As the supply of bankruptcy counsel and capital swells, competition by debtor’s attorneys for clients will grow fierce across the entire distressed market. One distinctive way for debtor’s attorneys to stand out in this market is by having access to DIP lenders in the debtor’s target market.

One challenge for average mid-market debtors is finding DIP lenders who lend to smaller companies. A dataset published by ABI of 112 DIP deals between 2006 and 2012^[3] included only three that involved amounts of under $10M, of which two involved less than $5M.^[4] Combining various loan facilities, the average DIP deal amounted to $613M.^[5] The largest DIP deal was for General Motors during the 2008 recession, with various loans totaling $33B.

The industry’s proclivity toward mega-deals can be seen even more clearly from the perspective of capital involvement. Creditors rarely invest in deals smaller than $10M, and 97% of all capital committed to DIP financing on public companies goes to deals larger than $100M. Private company DIPs are anecdotally believed to have the same mega skew.

As a result of this relative dearth in lower-middle-market DIP lenders, debtor’s attorneys who are able to provide financing options for their clients will have an advantage in client acquisition. Some important considerations in identifying and securing DIP financing include not only willingness to underwrite DIP loans in the appropriate amounts, but also the ability to get an answer in the appropriate time. Unlike larger debtors, small businesses typically enter bankruptcy with significantly less cash collateral and a much shorter time horizon to decide their bankruptcy strategy. Besides pursuing the obvious paths of pre-petition lenders and personal contacts of the debtor, debtor’s attorneys should also consider forming a Rolodex of exclusively third-party DIP lenders that can always fill in the gap.

As a result of COVID, small businesses are expected to suffer the greatest hit in revenue and file for bankruptcy in greater numbers than ever before. Chapter 11 debtors’ attorneys who are able to provide value for these smaller companies by connecting them with relevant DIP lenders who are able to provide <$10M in DIP loans will see their business grow as a result.